A total revamping of the process is called for to ensure independence of the directors

The institution of independent directors has been one of the most notable global innovations in recent times. So much so that without independent directors corporate governance seems a lost cause. However, the institution of independent directors is under an existential threat from within and without.

The Securities and Exchange Board of India (SEBI) has mandated that all listed companies should have a certain number of independent directors. The definition of an independent director brought in through the listing agreement with the stock exchanges is quite comprehensive. Unfortunately, the definition in the Companies Bill, 2008, cuts at the root of independence, which should be reviewed and corrected.

In practice, independent directors have largely remained independent only on paper. The recent Satyam fraud has created a fear psychosis in the minds of independent directors. This has been exacerbated by the Andhra Pradesh Government’s move to arrest former independent directors of Nagarjuna Finance for alleged default in repayment of public deposits.

The judicial response in the Nagarjuna Finance case has been anything but reassuring to independent directors.

Many independent directors have left and those who are continuing are not quite happy continuing. Unless the situation is remedied, there is a real danger of losing this nascent institution.

Protection

The moot question here is whether independent directors should have a statutory protection against arrests except in the most extraordinary of circumstances by the Central Regulatory Agency. In a country like India where foisting of criminal cases is quite common in certain segments of society, such a trend would be suicidal if allowed to affect independent directors. Hence, it is desirable that independent directors are given a statutory protection as stated above.

In the prevailing era where the Indian economy is slowly but surely integrating with the global economy, the need for a global reach and size cannot be ignored by the first hundred companies in India. It is true that a few of these today are owned predominantly by families. It is not an exaggeration to say that such companies would have to grow at an exponential rate to acquire a global size and reach.

To realise this the capital requirements would be beyond the reach of the controlling families. Such companies would have to access necessarily domestic and global capital markets for their capital needs. This can be done well only if the governance standards are quite high with competent independent directors providing the much needed re-assurance of the same.

Corporate frauds

Corporate frauds and scams greatly erode corporate wealth. Corporate India as a whole should have a vested interest in preventing and minimising corporate frauds and scams.

Independent directors on audit committees provide one of the best ways of reinforcing internal audit and annual statutory audit.

Thus, independent directors, who are truly independent, can be an effective bulwark against corporate frauds and scams. If corporate India is serious about raising the bar on governance standards, it should appoint competent independent directors after a thorough search.

Appointment

If a modicum of independence on the part of independent directors is to be ensured, a total revamping of the process is called for. Only the nomination committee of the board consisting solely of independent directors should have the responsibility to propose the names of independent directors.

The principal promoter of the company should disclose to the nomination committee the nature of any relationship that he has with the person(s) proposed to be appointed as independent directors of the company.

The nomination committee could release an advertisement in national newspapers giving stringent eligibility criteria for appointment of independent directors and calling for applications.

To avoid frivolous and unnecessary applications, a good system of pre-registration and screening could be introduced by the regulator so that only a person who is registered with the regulator would be eligible to respond to the advertisement.

After a small number of candidates is short-listed, the nomination committee should have a transparent system of selection of the candidate and the process of such selection should be put on the company’s website.

The actual appointment of an independent director should be only by postal ballot. All financial institutions, banks, mutual funds and foreign institutional investors, who are shareholders, should be encouraged by the Regulator to participate in such a postal ballot.

The nomination committee should give detailed reasons for nomination of a particular candidate in the explanatory statement to the resolution proposing the appointment.

The details of the votes cast for and against the proposal should be put on the website of the company.

Such an appointment based on the support of the broad spectrum of shareholders would give confidence to the candidate to be slightly independent of the overpowering influence of the principal promoter of the company.

Retirement

For ensuring better independence, both real and perceived, it would be appropriate that an independent director should not continue as such for more than two terms of three years each.

It is normally argued that such a move would not ensure proper experience in a particular industry, as the independent director has to move away after six years.

This argument would not always hold good if one were to look at independent directors as enlightened generalists who bring to bear upon everything that they do and think a certain freshness of approach without the bias of traditional experience and conventional thinking.

Further more, for industry experience, there are the executive directors on the board, to provide the necessary guidance to the independent directors on industry matters.

Hence, it would not be inappropriate to provide a ban on the continuance of the independent director on the same board beyond two terms.

It is also important that an independent director should not be on more than five boards so as to allow him sufficient time and focus to be an effective independent director on the existing boards. It is also desirable that the remuneration of the independent directors is reasonably attractive.

Training

Continuing education for independent directors would be highly desirable. Premier management and professional institutes are already running development programmes for independent directors. However, attendance at such programmes is yet to catch up.

The corporate governance report should give details of management development programmes attended by the independent directors of the company.

It would not be a bad idea to set up a self-regulatory body called ‘The Institute of Independent Directors’. It could be a top of the line institution to nurture, promote and regulate the profession of independent directors. This institution could be established in private public partnership as a self-regulating body for the orderly growth and regulation of the profession of independent directors.

Nurturing the profession of independent directors requires a great amount of restraint and imagination on the part of the regulators and the law enforcers so that eminent and honest people are not discouraged from being independent directors.

The future growth of India depends to a large extent on sustainable wealth creation by the corporate sector. Business leadership founded on a good corporate governance model can ensure such sustainable wealth creation to a large measure.

For this, independent directors are absolutely necessary.

Therefore, the task of nurturing the institution of independent directors as a national priority cannot be over-emphasised.

L. V. V. IYER, Corporate Lawyer. He can be contacted at: iyerassociates@sify.com

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